“This is a huge problem, but it is not wholly of CalPERS' making,” said Michael Sweet, a bankruptcy attorney with Fox Rothschild in San Francisco.

LOS ANGELES —Villa Park, an Orange County, Calif. city that once made Worth Magazine's list of the 300 wealthiest cities in America, might not at first glance appear to be a likely candidate for the short list of cities who have tried to exit the California Public Employees' Retirement System.

But Villa Park and several other cities that have contemplated bolting from the pension fund are not fiscally distressed. They are just reeling from reports of unfunded liabilities in their pension funds and news that CalPERS plans to raise rates by 50% over the next five years on its 450 member cities.

But CalPERS, the nation's largest pension fund with $300 billion in assets, changed the rules for cities looking to exit in December 2012. Those changes made an exit cost-prohibitive for most cities.

Villa Park's mayor and council passed a resolution on Sept. 23 that is the first step in pulling away from the pension fund. The resolution will trigger a report from CalPERS providing an estimate of the lump sum needed to exit.

"We want out," Villa Park Mayor Rick Barnett said. "We probably will not be able to get out, but at least we will see what the reality is with these pension funds."

Unlike bankrupt Stockton and San Bernardino, Villa Park is not in dire straits. Barnett said it gave city leaders pause when they saw payments to CalPERS rise from 13.8% of payroll in 2005 to a projected 30.6% for fiscal 2014.

Barnett, a bankruptcy attorney, said the city is fiscally sound and has always prepaid pension costs a year in advance. It doesn't want CalPERS' rising rates to "destroy all the hard work the fiscally conservative city leaders have accomplished in balancing budgets," he said.

Villa Park only has six employees. CalPERS estimated it would have cost the city $3.6 million if it had terminated on June 30, 2012, according to city documents -- more than the city's annual budget of $3 million.

Two municipalities have left CalPERS since February 2013, according to Rosanna Westmoreland, a CalPERS spokeswoman: Loyalton, and the Orange Cove Fire Protection District of Fresno and Tulare Counties.

Loyalton, a city of 729 just west of Reno, Nevada, only has one full-time employee and had one employee in CalPERS, said Mayor Brooks Mitchell.

That one employee resigned in November 2013, and the city exited CalPERS in February 2014. It still owes the $1.6 million termination cost, he said.

"We haven't paid it yet," Mitchell said. "We are still negotiating with CalPERS."

Loyalton decided to exit when it learned its rates were going to increase in a stair-step fashion from 19% to 29% during a three-year cycle, Mitchell said. The small Sierra County city has other financial problems. It is involved in litigation related to a discovery that city salaries and benefits were overpaid by $667,000 over a five-year period. The city's annual budget is $900,000.

Two other cities - Pacific Grove and Canyon Lake — sought to exit CalPERS in 2012, but were deterred by the cost.

"Certainly the amounts they are getting quoted are huge," said Michael Sweet, a bankruptcy attorney with Fox Rothschild in San Francisco. "This is a huge problem, but it is not wholly of CalPERS' making."

These cities made commitments to pay benefits with cost-of-living agreements and other enhancements that are really extraordinary, Sweet said.

"I don't think anyone stopped to think about the real cost of providing benefits to police officers and firefighters 30 years down the road," he said.

The way cost of living increases were set up under Stockton's pension plan, he said, retirees' annual benefit amounts would double in half the time it would take for a current employee's annual salary to double.

"Explain to me, why even if you wanted to do right by employees after they retire, you would give them bigger raises when they are no longer working?" Sweet asked.

Sweet said he understands the frustration with CalPERS, adding that the pension fund is culpable on some level, but there is "plenty of blame to go around."

Pacific Grove, a city of 15,295 in Monterey County, began discussions about exiting CalPERS in 2007. Mayor Bill Kampe said he wishes the city had completed the task then.

"CalPERS was in a surplus situation then for most agencies - at that time we could have left with cash in the bank," said Kampe. He was elected to the council in 2008. The city considered exiting the pension fund again in 2012, but found the cost quoted prohibitive.

Discussions about exiting came because the city is struggling to pay the carrying costs for the public safety contract it has with Monterey County, Kampe said. City leaders also believed that being a CalPERS member limits their ability to negotiate with unions. Like Villa Park, they would have liked to move away from a defined benefit plan.

In California, pension benefits can go up, but they will never go down, said Thomas Frutchey, Pacific Grove's city manager.

One potential loophole appeared during testimony in Stockton's bankruptcy case.

If a city terminated with CalPERS, CalPERS would have the power to lower employee benefits if the city were not able to pay the entire termination fee, according to an April 29 filing by CalPERS Deputy Chief Actuary David Lamoureux.

That window of opportunity would end when the termination transfer was complete. After that, if CalPERS long-term investment and demographic forecasts fell short, it could not return to the employer.

Although Pacific Grove has a strong balance sheet, partly as a result of selective outsourcing to other cities, it doesn't have pockets deep enough to exit CalPERS, Kampe said.

Since most CalPERS cities and agencies have underfunded pension systems, few have that option, he said.

"In August 2012, the CalPERS board decided to double the cost for any city leaving CalPERS," Frutchey said.

CalPERS dropped the discount rate to 7.5% for current agencies and to 4.25% for those looking to leave, which makes it much more expensive, Kampe said.

CalPERS uses actuarial information to make sure there is sufficient payment to cover employees vested pension rights accrued through the termination date, according to Lamoureux's testimony.

The termination payment goes into the Terminated Agency Pool. If the city fails to make the termination payment, Lamoureux said benefits may have to be reduced pro rata based on the amount of the termination payment that is not funded.

"Unlike in an ongoing plan, these risks cannot be addressed by adjusting contribution rates in future years," Lamoureux said. "Because there is no mechanism for receiving additional payments should the actuarial assumptions not be met, the investments in the Terminated Agency Pool, and the assumptions to determine the termination payment, must be more conservative."

When the board adopted the more conservative rate of return for the terminated agency pool, it also made the decision to invest the assets from that pool in less-risky Treasury bonds. That decision also meant that the actuarial liability upon termination is larger than the actuarial liability on an ongoing basis, Lamoureux said.

CalPERS principal responsibility is to maintain the integrity of the system so that retirees receive payments as promised on a reliable schedule, Lamoureux said.

Stakeholders around the state are watching to see if the San Bernardino and Stockton bankruptcies will change the rules that govern public pensions in the state. Those cases have pitted the pension fund against bondholders.

San Bernardino backed away from efforts to impair CalPERS after missing a years' worth of payments totaling $13 million to the pension fund. That city reached an agreement with CalPERS two months ago following a confidential mediation process. San Bernardino still hasn't crafted the plan of adjustment needed to exit bankruptcy and is still in negotiations with its firefighters union and bondholders.

It remains to be seen if cities that exit bankruptcy without impairing pensions will be hobbled by those obligations in the future. Vallejo, which exited bankruptcy in 2011, continues to struggle.

In Stockton, bondholder Franklin Templeton Investments, the last hold-out to that city's plan of adjustment wants the judge to impair CalPERS.

Franklin's attorneys contend in a Sept. 3 filing that the judge cannot approve a plan that provides full payment to the city's "massive pre-petition liability for unfunded pensions, delivers recoveries ranging from 52% to 100% for all other material unsecured creditors, yet crams down a sub-1% payment on Franklin."

Franklin's attorney James Johnston with Jones Day filed a 46-page post-trial brief ahead of an Oct. 1 status hearing asking U.S. Bankruptcy Judge Christopher Klein to deny plan confirmation and send the city back to the drawing board. It asked that the city treat Franklin fairly or impose the same draconian impairment on all of its creditors including "taking advantage of its ability to discharge its prepetition pension liability and other debts."

The cost to terminate for smaller cities is negligible compared to what it would cost Stockton. Lamoureux testified that Stockton's cost to terminate would be a debt, immediately due, of $1.6 billion.

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